A swap execution facility, or SEF, is a regulated transaction platform created under the Dodd-Frank Wall Street Reform Act (title VII). Dodd-Frank requires non-bilateral swaps to be transacted through a formal platform or via a SEF, using a using a designated contract market (DCM). This new form of regulation amends what was previously known as the Commodity Exchange Act (CEA). The market for swaps transactions is currently estimated to be approximately $350 trillion.
Swaps are derivatives contracts for such items as interest rates and credit defaults, and have been generally bilateral, over-the-counter (OTC) trades. Much of the Dodd-Frank reforms have been aimed at bringing transparency into the way most derivative contracts are processed. The creation of SEFs, like many other components of Dodd Frank, has been established in order to mitigate future systematic risk and to prevent economic crises that were caused by poorly created and executed OTC transactions.
US government regulators the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) are driving the reforms for the OTC derivatives markets and any entity seeking to become a SEF must gain approval by the CFTC.
For now, there are four guidelines a SEF must follow:
1) To provide a “multiple-to-multiple” facility where quotes are made available to all participants
2) Any SEF using request for quotes (RFQs) must make certain they are made to at least five participants
3) The SEF must inform the requester of all bids and offers regarding the swap for which a quote has been made
4) The SEF must permit brokers to execute trades on both sides of the OTC transaction
Most swaps are currently traded manually over the phone. However, the initiation of SEFs as electronic transaction venues is likely to spur an expansion in electronic trading for OTC instruments, according to industry observers. One of the first tests of a regulated OTC transaction was Tradeweb’s facilitated trade in November 2010, which was then processed by a clearinghouse.
The US Senate is currently debating the latest version of the SEF bill. Recently, the CTFC delayed the date for the swap transaction regulation to become official. The initial date for SEF usage was scheduled for July 14, 2011, but the deadline has been extended to December 31, 2012.